September 01, 2007

Decoupling Decision Rights and Decentralization

Andrew McAfee has an interesting post that challenges the trend of decentralization in organizations. Noting Tom Malone's work on how decreased communication costs enable more decentralized decision rights, he makes a distinction between information and knowledge. You can now provide information to any potential decision maker at a low cost, but the best tacit knowledge for a given decision may reside in someone the core of an organization instead of the assumed edge.

Let’s say that a mortgage company realized that a few of its loan
officers were just better at assessing credit risk than all the others.
For whatever reasons (intelligence, experience, intuition, etc. ), they
just had superior specific knowledge. In that situation, it would make
good sense not to decentralize, but instead to centralize that decision
right within the company, taking it away from the other loan officers.
All the general knowledge (income statements, credit histories, etc.)
would be sent to these few people, who would apply their specific
knowledge to it and made decisions. In this example low information
costs are still important; they allow all the general knowledge to be
zipped to the few good officers. But the effect of low information
costs isn’t decentralization and greater empowerment. Instead, it’s
centralization of an important decision right and reduced autonomy for
most loan officers.

Thought experiments like this one indicate to me that the net result
of disappearing information costs won’t necessarily be
decentralization. It will instead be the decoupling of information flows and decision rights.
Organization designers will be able to allocate decision rights without
worrying about how costly it will be to get required information to
deciders. Leaders will be able to ask "Who should make this decision?"
without adding "Keeping in mind that it’s going to be slow, difficult,
and expensive to get them the general knowledge they’ll need."

Will this work always, or even usually, lead to more decentralized
organizations? I find myself less confident than Malone that this will
be the case. I agree with him that we’re at a very interesting point in
the history of technology and the economics of information, but I’d
label it a great decoupling (of information flow and decision rights)
rather than a broad decentralization (as decision rights lateralize
along with information flows).

Information has no value until it informs a decision that results in an outcome. This is part of why it wants to be free and increasingly is. The decider certainly plays a role in this equation. But something concerns me about this Carr-esque classification of decision making capabilities based on tacit knowlege (what is it about theories from Harvard on expertise ;-P). And I don't think it is enough to buck the trend of decentralization.

Decreasing communication costs and ubiquitous information begets transparency. While the future impact of IT provides both the directions of strong crypto and transparent society, with uncharted privacy implications and policy -- I believe transparency is a greater force. Especially when it comes to revealing bad decisions.

Lets take Andrew's mortgage company example. First, celebrate that the organization can change structure from the decoupling of information and decision rights. Then, note it can shift back. If a group gains centralized decision making capabilities because of their, augmented by "general" information, it is in a good position to execute the decision making process.

But my read of Malone's book is it is not just about decreasing communications costs that enable decentralization, but how decentralized organizations can scale. I believe Andrew is suggesting that information systems that automate information processing enables this group to scale its capabilities. At first glance, this is similar to how trading desks work. But approving a mortgage for an individual is very different from institutional trading. Markets are social and the actors in institutional trading actually rely on relationships, and by doing so improve their tacit knowledge and handle exceptions better. By taking the social interaction out of the hands of the mortgage officer who is closer to the actual customer and in a position to assess different kinds of risks beyond the FICO score. And perhaps worse in the long term, it dehumanizes the organization's capability to develop a relationship with the customer.

Perhaps I am being too prescriptive with the business model, and maybe sidestepped the issue by hypothesizing there is a different kind of tacit knowledge at the periphery of the organization. But the point is some kinds of tacit knowledge and decision making capability, those best at detecting and handling exceptions to business processes, may not be scalable through automation and centralization.

What I really like about Andrew's idea is the ability to reassign decision rights because they are decoupled from information. Good thing too, because corporations don't have deciding who is best to decide down to a science. Given the potential transparency in an organization, we may get better at more broadly handling exceptions and learning from decisions made. We may actually discover who influences makes decisions. But my long term belief in decentralized organization recognizes that it is the environment the organization exists within, not that inside the organization, that creates the greatest amount of exceptions. And the organizations that put decision rights closer to exceptions are more likely to adapt and survive.

Perhaps a better structure is to encourage decoupling of decision rights

Comments

Decoupling Decision Rights and Decentralization

Andrew McAfee has an interesting post that challenges the trend of decentralization in organizations. Noting Tom Malone's work on how decreased communication costs enable more decentralized decision rights, he makes a distinction between information and knowledge. You can now provide information to any potential decision maker at a low cost, but the best tacit knowledge for a given decision may reside in someone the core of an organization instead of the assumed edge.

Let’s say that a mortgage company realized that a few of its loan
officers were just better at assessing credit risk than all the others.
For whatever reasons (intelligence, experience, intuition, etc. ), they
just had superior specific knowledge. In that situation, it would make
good sense not to decentralize, but instead to centralize that decision
right within the company, taking it away from the other loan officers.
All the general knowledge (income statements, credit histories, etc.)
would be sent to these few people, who would apply their specific
knowledge to it and made decisions. In this example low information
costs are still important; they allow all the general knowledge to be
zipped to the few good officers. But the effect of low information
costs isn’t decentralization and greater empowerment. Instead, it’s
centralization of an important decision right and reduced autonomy for
most loan officers.

Thought experiments like this one indicate to me that the net result
of disappearing information costs won’t necessarily be
decentralization. It will instead be the decoupling of information flows and decision rights.
Organization designers will be able to allocate decision rights without
worrying about how costly it will be to get required information to
deciders. Leaders will be able to ask "Who should make this decision?"
without adding "Keeping in mind that it’s going to be slow, difficult,
and expensive to get them the general knowledge they’ll need."

Will this work always, or even usually, lead to more decentralized
organizations? I find myself less confident than Malone that this will
be the case. I agree with him that we’re at a very interesting point in
the history of technology and the economics of information, but I’d
label it a great decoupling (of information flow and decision rights)
rather than a broad decentralization (as decision rights lateralize
along with information flows).

Information has no value until it informs a decision that results in an outcome. This is part of why it wants to be free and increasingly is. The decider certainly plays a role in this equation. But something concerns me about this Carr-esque classification of decision making capabilities based on tacit knowlege (what is it about theories from Harvard on expertise ;-P). And I don't think it is enough to buck the trend of decentralization.

Decreasing communication costs and ubiquitous information begets transparency. While the future impact of IT provides both the directions of strong crypto and transparent society, with uncharted privacy implications and policy -- I believe transparency is a greater force. Especially when it comes to revealing bad decisions.

Lets take Andrew's mortgage company example. First, celebrate that the organization can change structure from the decoupling of information and decision rights. Then, note it can shift back. If a group gains centralized decision making capabilities because of their, augmented by "general" information, it is in a good position to execute the decision making process.

But my read of Malone's book is it is not just about decreasing communications costs that enable decentralization, but how decentralized organizations can scale. I believe Andrew is suggesting that information systems that automate information processing enables this group to scale its capabilities. At first glance, this is similar to how trading desks work. But approving a mortgage for an individual is very different from institutional trading. Markets are social and the actors in institutional trading actually rely on relationships, and by doing so improve their tacit knowledge and handle exceptions better. By taking the social interaction out of the hands of the mortgage officer who is closer to the actual customer and in a position to assess different kinds of risks beyond the FICO score. And perhaps worse in the long term, it dehumanizes the organization's capability to develop a relationship with the customer.

Perhaps I am being too prescriptive with the business model, and maybe sidestepped the issue by hypothesizing there is a different kind of tacit knowledge at the periphery of the organization. But the point is some kinds of tacit knowledge and decision making capability, those best at detecting and handling exceptions to business processes, may not be scalable through automation and centralization.

What I really like about Andrew's idea is the ability to reassign decision rights because they are decoupled from information. Good thing too, because corporations don't have deciding who is best to decide down to a science. Given the potential transparency in an organization, we may get better at more broadly handling exceptions and learning from decisions made. We may actually discover who influences makes decisions. But my long term belief in decentralized organization recognizes that it is the environment the organization exists within, not that inside the organization, that creates the greatest amount of exceptions. And the organizations that put decision rights closer to exceptions are more likely to adapt and survive.

Perhaps a better structure is to encourage decoupling of decision rights